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EMS Technologies, Inc. (NASDAQ:ELMG)

Q4 2009 Earnings Call

March 10, 2010 9:30 am ET

Executives

Perry Tanner – VP, Marketing & Information Management

Neil Mackay – President and CEO

Gary Shell – SVP, CFO and Treasurer

Analysts

Rich Valera – Needham & Company

Mark Jordan – Noble Financial

Michael Ciarmoli – Boenning & Scattergood

Ryan Rackley – Raymond James

Operator

Good morning, ladies and gentlemen, and welcome to your EMS 2009 year-end results earnings call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. (Operator Instructions).

At this time, it is my pleasure to turn the floor over to Perry Tanner, Vice President of Marketing. Sir, the floor is yours.

Perry Tanner

Thank you, Christine. Good morning, everyone. Thank you for joining us today on EMS Technologies fourth quarter 2009 earnings call. With us today is Dr. Neil Mackay, EMS Technologies' President and CEO and Gary Shell, our Chief Financial Officer.

Neil will provide brief introductory comments and then Gary will review the financials. After the financial overview, Neil will offer more highlights on the company's operating segments and market conditions before providing an update on the company's 2010 outlook. After that, Neil and Gary will take any questions you might have.

Before we go further, any statements made during the call – the course of this call regarding product expectations, program opportunities, schedules, and future financial results are forward-looking statements. Actual events and results could of course differ materially. I refer you to the statement of Risk Factors in our Annual Report on Form 10-K for the year ending December 31st, 2008, and to our press release. These documents identify important factors that could cause such a variance.

Our remarks will also include certain non-GAAP measures of financial performance. Please refer to our press release, which is available on the company’s website at the Press Room page for a discussion of any non-GAAP measures.

During the course of this call, we will take questions from participants. Under SEC rules, we cannot provide material information in subsequent private settings, but we will continue this public call, as needed, to respond to the appropriate questions.

At this time, I will turn the call over to Dr. Neil Mackay, EMS Technologies' President and CEO.

Neil Mackay

Well, thank you, Perry. And good morning to all of you on this call. I'll start this morning by making three points important to the last quarter and to our business in general and then make some additional comments after our CFO discusses the financials.

First, it's important to note that the fourth quarter results were above most expectations and we finished the year near the high end of our previous earnings guidance. For the quarter, we reported revenue of $85 million, adjusted earnings of $0.16 per share, adjusted EBITDA of $8 million, and cash flow of almost $9 million from continuing operations.

Due largely to the economy, fourth quarter sales and EBITDA in 2009 were down somewhat from 2008. But when compared with this year's third quarter, our fourth quarter sales lagged slightly, but adjusted EBITDA increased by $1 million. Higher aviation revenues and the benefit of our restructuring efforts were significant factors in this improved profitability. Our view is that we are handling these difficult times reasonably well.

My second point is that the fundamentals of our LXE business continue to improve. Although we reported a significant impairment of LXE goodwill in the fourth quarter, it's a non-cash charge that does not affect the future profitability or the business prospects of LXE. In fact, over the past year, we have lowered LXE's cost structure by over $6 million on an annualized basis, we've reduced future expenses by outsourcing some design and manufacturing, and successfully expanded our indirect channel sales.

And additionally, our traditional North American markets for LXE products appear to be improving and we are developing new products that are helping us to expand into the tracking and logistics method – markets beyond the warehouse. An example is the MX9, a wide-area network product introduced earlier this year that has already attracted 50 new customers to EMS.

Now, the third point I'd like to make is that the quarter's results point to the strategic development of EMS Technologies as a mobile connectivity company. This can be seen in the way our Defense business is evolving, in the growth of our global tracking business, and our consolidation plans for our new aviation business unit.

I'll talk more about these after Gary's remarks. But none of this would be possible without the commitment of our 1,000 employees worldwide. Everyone is pitching in to help keep our costs down and I'm pleased with the gracious collaboration that is growing across our company's divisions.

I'd like now to turn the call over to Gary Shell, our Chief Financial Officer.

Gary Shell

Thanks, Neil. Fourth quarter consolidated earnings improved from the third quarter due to nearly $3 million of higher aviation orders, as well as cost reductions across the board.

For the Communications and Tracking segment, revenues in our legacy aeronautical business reflected the overall market trend and were down about 22% in the fourth quarter of 2009 versus 2008. In the current economic and market environment, we believe that order slip, not order loss is the main problem. This decline in organic revenue was more than offset by growth from our acquisitions, which added $15 million of sales to the segment in the fourth quarter.

For LXE, fourth quarter revenues were down 19% in 2009 versus 2008, but up 12% versus the third quarter of this year. The improvement from Q3 related mainly to orders from the North American market, which appears to be showing early signs of a recovery.

Defense & Space managed to basically break even for the fourth quarter despite the more than $6 million revenue drop and $1 million of restructuring costs that followed the end of work on the B-2 project. D&S also had to overcome some cost growth on development-stage programs, but offsetting many of these negative factors were a profitable execution on production-stage contracts and very strict cost controls.

A few more comments about the fourth quarter consolidated P&L. The consolidated cost of sales percentage for the quarter was 65%, which is somewhat lower than in either the third quarter of 2009 or the fourth quarter of 2008. This improvement reflected a more favorable sales mix with higher aviation related revenues, which typically have a lower cost of sales than other commercial products.

SG&A as a percentage of revenues increased slightly to 25% of sales, which was reasonably consistent with both the prior quarter of 2009 and our quarterly level of expenditures throughout 2008. R&D was up from the comparable period in 2008 and the preceding period in 2009 as all segments continued to invest in development of new products and capabilities.

Our overall R&D spend is actually higher than the reported amounts, because customer-funded R&D is included in cost of sales. In addition, R&D is reported net of benefits received through a Canadian government program that encourages technology development in certain qualified business areas such as satellite communications. We expect that the rate of R&D spending will increase in 2010.

As described in detail in the earnings release, the company conducted its normal year-end evaluation of goodwill, resulting in a significant non-cash impairment charge for goodwill at LXE. This charge was driven by the effect of the 2009 economic downturn on LXE's markets. The LXE goodwill impairment has no effect on the company's forecast for the LXE business or the company's compliance with the terms of its credit facility.

We are still working to finalize the specific amount of the impairment charge, which the company expects to be in the range of $16 million to $21 million. For a disclosure in the financial tables of the earnings release, we have assumed an impairment loss at the midpoint of this range.

The estimated impairment charge is much higher than the $5 million deficiency, by which LXE's total carrying value at the end of the year exceeded its estimated total fair value. That's because the required methodology for calculating possible impairment results in significant value being attributed to unrecorded assets such as intellectual property and customer relationships and trademarks instead of goodwill and although goodwill will be written down, these other assets are never recorded on the books or written up to fair value.

Similar to the previous quarters in 2009, we presented supplemental information in this morning's earnings release about net earnings and earnings per share on a non-GAAP basis. These non-GAAP results exclude not only the goodwill impairment charge at LXE, but also items related to our earlier acquisition activities. We believe that exclusion of these items provides very useful information about the results of our ongoing operating activities, as well as providing information that is more comparable to the prior periods.

In the fourth quarter, the company settled an earnout provision for one of the acquisitions. The settlement was in line with previous estimates of the eventual payout. The resulting $1.9 million charge mainly represented accretion that would have otherwise been expensed in 2010 so there should now be no further acquisition charges in future P&Ls related to our 2009 acquisition activities. This accounting treatment is newly required in 2009 under FASB Statement 141(NYSE:R).

In non-operating, the foreign currency exchange adjustment reported in Q4 relates mainly to the net change in the value of receivables and payables in a translated currency. This P&L amount was relatively small because of the effectiveness of our ongoing program to hedge these balance sheet exposures.

However, foreign currency exchange rates were a key operating issue in 2009. In particular, the weakening of the U.S. dollar versus the Canadian dollar during 2009 was not favorable to our Communications and Tracking segment, which sells mostly in U.S. dollars and has significant manufacturing operations in Canada. For the full year 2009, our operating profit was approximately $4 million lower than it would have been if the stronger U.S. dollar exchange rates from the beginning of the year were still in effect.

A couple of additional points about financial results. First, Defense & Space ended the period with another good backlog of approximately $90 million. And in January 2010, we announced that we were combining as a single entity the businesses within the Communications and Tracking segment that focus on aviation.

As a result, in 2010, we expect to divide the present Communications and Tracking reporting segment into two reporting segments, EMS Aviation and Global Tracking. However, since this redefinition of our business occurred after the end of 2009, we have made financial disclosures for 2009 consistent with prior periods. Historical comparative data that will be presented in 2010 and beyond will be appropriately recast to reflect the new segment definition.

Turning briefly to the balance sheet, the company generated cash from operations of $9.4 million. The balance remaining of the revolver debt is only $18.5 million and represents leverage of well less than 1 times annualized adjusted EBITDA. Our cash carrying balances were $47 million as compared with total debt of approximately $28 million. Trade receivables and inventories decreased during the fourth quarter. Our financial position remains very strong.

Neil, this concludes my comments on the Q4 financials.

Neil Mackay

Okay. Thank you, Gary. Now, I'll spend a bit of time discussing the fourth quarter 2009 in total and our view of the coming year.

Let me begin by saying that EMS Technologies is focused on mobile connectivity. As Gary mentioned, we reorganized our business in January to reflect this evolving strategy. But however since 2009 results reflect the way we were organized back in 2009, I'll discuss the business on this call as three separate segments consisting of Defense & Space, LXE Logistics, and Communications and Tracking.

Let's start with Defense & Space. Our D&S business has been challenged with closing the gap left by the end of the B-2 program. We have a strategy for doing that. First, we have resized the business to maintain profitability, reducing operating costs by about $5 million. Second, we have created a new business development team focused on finding programs with more long-term production opportunities. We are seeing some early successes. I believe we will continue to improve the outlook of this segment later on.

In the Defense portion of our business, we have two areas of opportunity, radar and comms-on-the-move. 70% of the Defense & Space business will be in these areas and two-thirds of our 2010 sales are already in backlog. With radar, we are involved in eight radar programs for the army, air force, and navy and we are positioned on three others. Of most interest to us are those supporting applications for the navy and air force, since they have higher volume production potential.

Now, for comms-on-the-move. Our new product-oriented focus helped EMS Technologies capture the first $5 million order from L-3 for the Hawklink helicopter program. With the large number of helicopters to be outfitted, we estimate that this product could eventually generate sales of some $30 million over the next five to six years and we also expect to apply these data link products to the adjacent markets.

On the Space side of our D&S business, the commercial satellite communications market is moving up to Ku-band technology for broadband connectivity. This is an area where we can exploit our rich expertise. As an example, we received an order for $5 million from Orbital Sciences to provide hardware for European Ku-band communications satellite. This work also helps us to solidify our own Ku-band expertise for future SATCOM opportunities.

Turning now to our LXE Logistics business, we believe the path of success is pretty straightforward. We will return to profitability, we will improve our channels to market, and we will capitalize on the available synergies for the Communications and Tracking group. As you may know, we have been following this path through most of 2009. So I'll only give a summary here of our progress at this time.

There are three facets to this strategy. We significantly improved LXE's cost structure during 2009. We partnered with outside design and manufacturing vendors and we improved our internal processes to give us higher productivity. This has been key to reducing our breakeven point, but as well it helped to improve our time to product launch.

Second point is we have changed our distribution model to be more indirect, which reduced selling costs further and provided us with access to more value-added resellers at the market. This strategy is now paying dividends. By the end of the fourth quarter of 2009 for instance, we doubled the number of partners signing up with LXE through partner recruitment campaigns and so a double-digit year-over-year growth in distribution revenue in the Americas and Europe. Sales momentum through channel partners such as BlueStar, Barex, and ScanSource continues to grow.

The third and key strategic item on our list has been to extend our logistics solutions beyond the warehouse. I mentioned earlier that our first wireless wide-area network WAN product, the MX9, has been delivered to our launch customer Itron, the world's largest producer of meter reading systems. But we've also shipped the MX9 to 50 other customers. The MX9 will soon be followed by new lines of WAN products starting in the spring and fall of 2010. This is a significant advantage for LXE. It's opening up new markets, it's attracting a lot of interest from our borrowers and bringing LXE closer to the EMS mobile connectivity fold.

LXE is moving into 2010 with the highest backlog we've seen in over five years. Four of our largest orders during Q4 reflect our presence in the agricultural, automotive, chemical distribution and consumer products industries and these are worth over $3 million. What we don't know yet is whether this is an event or trend. We are pleased to be where we are with orders right now, but we are cautious about over-predicting so early in the business cycle.

Now, let's turn to the Communications and Tracking business. We will discuss tracking first and then communications. Our tracking revenues will be reported separately in 2010 as a segment to be known as Global Tracking as the result of successfully integrating Satamatics, one of our acquisitions, with two other legacy tracking and search and rescue segments of EMS. Customers range from NATO troops in Afghanistan and Pakistan, contractors supplying those troops, fishing fleets, and agencies involved in personnel location and recovery. We provide the hardware and service, our customers develop the applications.

Global Tracking uses three satellite systems for its various services. Those are Inmarsat, Iridium, or the international Cospas-Sarsat network. Current global tracking revenues are split 50-50 between hardware and airtime services and it's the fastest growing segment of EMS Technologies, supporting the logistics of troop movements and its supply chain, as well as tracking high-value assets whether they be individuals or cargo moving from warehouse to warehouse.

Later this year, we expect to launch our Osprey Personal Tracker product, which is in beta trials as we speak. The Osprey will offer a very robust global commercial personnel tracking service. As EMS Technologies continues to evolve and grow, I expect to see more collaboration between global tracking and our other commercial businesses.

Now, for the communications section – segment of our C&T group. The communications revenues from C&T segment are best described as our aviation connectivity group. In 2010, we were reported under the name of EMS Aviation consisting of the former EMS SATCOM, EMS Sky Connect, and EMS Formation units.

The recent decline in the business aviation market is no secret and is reflected in our fourth quarter sales, which were virtually flat for 2009. Most market reports are predicting flat sales for the first half of 2010 with cautious optimism for the second half of the year. But it's important to note however that EMS Aviation covers much more than the business aviation market. We have a presence in most every solution being provided for aero-connectivity.

Besides business aircraft, you will see us on helicopters, long-range or domestic commercial airlines, military platforms, and even UAVs. At this time, the aviation market is served by four connectivity systems, air-to-ground, Iridium, Ku-band, and Inmarsat. EMS enables connectivity with all of them. In air-to-ground systems, EMS provides Aircell Gogo terminal products. The system is now offered on more than 700 commercial aircraft including Delta and AirTran airlines who are lead customers. Aircell recently announced its two-millionth customer milestone. During the fourth quarter, we shipped the largest single-day Aircell order ever, valued at $3.6 million.

With the Iridium system, our acquisition of Sky Connect gave us a foothold in the Iridium satellite communications business. This was important to EMS because Iridium system is attractive to price-sensitive customers including small jet and helicopter markets. Although hardware sales to Iridium customers were down in Q4 due to lower usage of helicopters in the offshore oil market, our airtime service business held steady throughout the quarter.

We addressed the Ku-band market with antennas and in-cabin equipment. Both Southwest Airlines in the U.S. and Lufthansa in Europe are planning to deploy Ku-band connectivity on their airline fleets and EMS Technologies will be on board.

Now, our Inmarsat system addresses business jets, commercial air transport, and the military where Inmarsat connectivity continues to be crucial for global communications. Growth of Inmarsat connectivity continued during the quarter with both military and commercial customers ordering our trademarked eNfusion systems. EMS equipment is now on approximately 1,000 aircraft and we expect this market to continue to grow.

In January of this year, the three segments of our aviation business were consolidated into the new group called EMS Aviation. This is important for three reasons. First, it gives EMS a stronger presence in this important segment. Second, it provides a comprehensive solution to the market, bringing together all the previous separate product lines. And third, it creates synergetic results which will improve our profitability.

We now have in one business the technologies that make aero-connectivity possible including antennas, radios, routers, servers, data storage, and wireless networks. No other company, I believe, offers such a robust connectivity portfolio for virtually any type of aircraft.

During 2010, we expect significant advantage from this new market leverage. Ironically, the aviation industry is the least served by connectivity solutions, yet we have the most to gain by adopting them. It will bring improved profitability, operational efficiencies, and passenger satisfaction.

In concluding, I'd like to remind you that we have a solid growth strategy, a strong balance sheet, and a track record of success. We are committed to the mobile connectivity markets in aviation, in logistics, and defense. We remain vigilant in managing costs and finding new ways to address market opportunities and growth. If we give credit to our plans and combine that with signs of an improving economic outlook, I'm optimistic about our long-term business prospects, but we remain cautious however about the impact of the economic environment in the short term.

For 2010, we expect single-digit-percentage growth in overall revenues and adjusted EBITDA. Due to current market and economic conditions, as well as seasonal business cycles in our markets, we believe that earnings will be weighted toward the second half of the year. And we expect that earnings from continuing operations will be in the range of $0.75 to $0.90 per share, excluding acquisition-related charges and assuming an effective income tax rate of 15%.

I’d like now to turn the call back to Christine, who will handle the questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Please hold while we poll for questions. Thank you. Our first question comes from Rich Valera of Needham & Company. Please state your question.

Rich Valera – Needham & Company

Good morning. First, Neil, I would like to welcome you and wish you the best of luck in your new role as CEO. With respect to your guidance for the full year, you are talking about a quite a large range, essentially 1% to 9%. I'm wondering if you can give any color on the factors that could drive you to the lower or upper end of that range, particularly in light of the fact that I guess Defense & Space we would assume would be down by something in the – probably the low-double digits.

Neil Mackay

Thanks, Rich. Of course, a good piece of it is what's going to happen to the economy. Gary, would you like to answer on this?

Gary Shell

Yes, I think, Rich, the big uncertainty which translates into the upside potential is going to be how the markets hold up. We know that the LXE business looks like – based on the competitors in the market, the outlook seems to be improving and if that uptick works out for them that could certainly be an upper.

The aviation business of course is really important in terms of how that works out. Most of the competitors in the area, big players in the business, are showing flat-to-low growth in 2010, but there are some opportunities for us to be able to certainly hold our own with that, do better than that if – with some product initiatives possibly and so that would also be the uptick.

I think the key thing for us is – it – the plan is weighted more towards the back-half as typically what we are seeing with the competitors in all of our markets and we will know a lot more about what the upside or how things are shaking out as we – obviously as we get through towards the middle of the year.

Rich Valera – Needham & Company

Can you, say, give us any help maybe with respect to historical patterns in terms of either first quarter seasonality or back-half weighting, understanding last year was not a typical year, but should we sort of look at prior years to get a sense of how back-half weighted we should think about the year?

Gary Shell

Yes. I think that's true. First quarter has typically been not a fun quarter, that's historically our poorest performing quarter. We usually have some recovery in Q2, often times actually drop back a little bit in 3 or slow growth in 3 because the effect of vacation – this vacation cycle frankly in Europe and Q4 is typically our strongest quarter.

Rich Valera – Needham & Company

Okay, that’s helpful color. Sounds like you saw a nice recovery in your business with Aircell with that large shipment in the quarter. Any concern about that being – creating sort of an inventory situation there? Do you have any sense of how quickly they plan to work through that order?

Neil Mackay

Well, we can't talk about Aircell specifically, Rich, but I – what they like to do is they are installing these things on various fleets, some of them are five to six a night as they say and what they like is to get a big batch so that they could provide it to the airlines at the right time so that they can move them through the hanger as fast as possible. So all our business tends come in that way, we get large deliveries on a periodic basis.

As far as the Aircell is concerned, they still seem to be very bullish on what they are doing. They have a mass of customers that they have not yet installed anything on or they are just doing trials. So I suspect 2010 will look pretty good as far as the deliveries are concerned.

Rich Valera – Needham & Company

That’s helpful. And with respect to LXE, sounds like you are seeing an encouraging level of bookings there. So it sounds like maybe we could expect to see less than typical seasonal decline in that business into the first quarter. Is that a fair assessment, Gary?

Gary Shell

I think the biggest challenge there, Rich, is if the world only depended on what happens in North America, I'd say I'm with you. But we depend on – about half of our revenues here in recent years have come from the European market and that economic uncertainty over there, we just don't know exactly how that's going to play out right now in terms of the capital acquisition cycle.

Rich Valera – Needham & Company

Great. And just one more on LXE, if I could. I think you guys know you've gotten questions many times over the years about the strategic importance of that business, how you view that. Anything you are willing to say at this point how you view that business strategically?

Neil Mackay

Well, a few things have happened over the last year. If you looked at LXE back in 2007, we were somewhat entrapped in the warehouse and ports market, because all of our technology was Wi-Fi based. So over 2009, we have gone about a program to ensure that they have the capability to get out of the warehouse. So the new MX9 and the products that are coming behind that are very much giving them that opportunity.

With that and also getting into an indirect model, strangely – strange as it may seem, we are now finding a lot of our VARs really want to have the products that are outside the warehouse. So we are going through the process now of trying to build up a better approach to non-warehouse applications. We are still heavily involved of course in the warehouse side, but we are seeing an interesting new business starting to emerge outside the warehouse.

Rich Valera – Needham & Company

Great. That’s helpful. Thanks, guys.

Operator

Thank you. And our next question comes from Mark Jordan of Noble Financial. Please state your question.

Mark Jordan – Noble Financial

Yes, good morning, gentlemen. I would like to talk a little bit about the accounting issues for LXE and goodwill. If I understand from the press release, you've said that there was a $5 million decline in value, about a potential $16 million to $21 million goodwill write-off. I assume therefore that the difference between $5 million and $16 million to – $11 million to $16 million is the amount of a – of appreciation of assets that were not previously booked and so therefore you wrote up the assets of LXE by $11 million to $16 million. Is that the correct mechanics?

Gary Shell

It's not correct that we've actually wrote it up, Mark. That’s how you go through the mechanics of calculating it, you attribute value to all sorts of intangibles, as I mentioned, that aren’t on our books. You sort of do that calculation on the side to calculate what goodwill would be and to the extent you have to put it, you have – you did state it exactly right. To the extent we have to attribute value to intangibles and to appreciated fixed assets, appreciated property that kind of thing, that takes directly away from the amount of value that goes to goodwill.

So the kicker though in the way the accounting works out is you have to take the hit on goodwill, but you don't get to write anything else up.

Mark Jordan – Noble Financial

Okay. And then the next question related to that is you had – you showed $91.7 million in assets at LXE at the end of the third quarter. When we see this in the fourth quarter, how much goodwill will be left at LXE and do you have a sense as to what the asset size will be?

Gary Shell

Well, I think the – what's just basically in play is most of LXE's goodwill, a big chunk of that goes all the way back over 10 years when we purchased the minority interest of LXE when that used to trade on the – as a separate stock. Then we've had a couple of acquisitions over time. So it's kind of a mixed bag and so what the – the number we are talking about is basically all of LXE's goodwill. Everything else should stay about the same.

Mark Jordan – Noble Financial

Okay.

Gary Shell

Although they have – yes, we have talked about that LXE has done a very good job at driving down their inventories and their receivables and we don't actually keep their cash on their balance sheet. It goes up to corporate.

Mark Jordan – Noble Financial

Okay. And I guess last – another question related to that then to summarize all this, when we see that asset number in the 10-K, that will be effectively tangible book assets and if you were to look at the market value, we would – we could then, say, add on again that difference between $11 million and $16 million and that will be sort of a market book value?

Gary Shell

Yes, I think if I follow your question right, Mark, what you should see in the 10-K will be after we have written off most, if not all, of LXE's goodwill. So yes, what will be left is basically tangible book.

Mark Jordan – Noble Financial

Tangible book? And then if you are looking at market, you would be – that incremental $11 million and $16 million, you would add than on also?

Gary Shell

Okay.

Mark Jordan – Noble Financial

Okay. One quick question relative to back to Richard's one on seasonality. I mean, can you sit there and say, you are going to – that the first quarter, given the seasonality, will be profitable quarter, but modest or can you give us any color as to which side of the plus or minus it might be on?

Gary Shell

Q1s are always very modest in the best of years, because we are coming off the high point of the acquisition cycles in a lot of our markets. So there is a recovery period. So Q1s are always very modest. But we don't plan on loser quarters.

Mark Jordan – Noble Financial

Okay, fine. Last question, D&S, is the fourth quarter – should that be the low point from a revenue standpoint for that group?

Gary Shell

I think sort of how it charts out. They – they are –

Neil Mackay

We also took some restructuring costs –

Gary Shell

Yes, but just from a revenue perspective, I think in –

Mark Jordan – Noble Financial

Yes.

Gary Shell

It should be – that should be a low point. There maybe some of the – they certainly – they began to – with some orders, began to fill in some of that hole already in Q4. Now, it's going to take a little while to do that and it may take a while to get those into the flow of the way that it should work out for to converting that into revenue, but that should be something of a low point.

Neil Mackay

Yes, there is not much seasonality, Mark, on the D&S side. We are seeing growth, but that's towards the end of the year as well. But there is not a seasonality there. There is more in the other groups.

Mark Jordan – Noble Financial

Okay. Thank you very much.

Neil Mackay

Okay.

Operator

And our next question comes from Michael Ciarmoli of Boenning & Scattergood. Please state your question.

Michael Ciarmoli – Boenning & Scattergood

Hey, good morning, guys. Thanks for taking my questions.

Neil Mackay

Good morning, Mike.

Michael Ciarmoli – Boenning & Scattergood

Gary, just on the bottom-line guidance, $0.75 to $0.90, just trying to get an apples-to-apples, that compares with $1.01. So what's assumed in there in terms of that you are – I'm assuming that's sort of a non-GAAP number you are adding back some amortization, what's kind of assumed in there, some of your non-GAAP items?

Gary Shell

Well, the – really the only non-GAAP now that we are – that you would want to do if you are trying to get an apples-to-apples is DAA, depreciation and amortization. We are – we've gotten rid of – by this last little cleanup on $1.9 million. There won't be any acquisition hangover relative to what we did in 2009. So the only thing is the depreciation and amortization, which – that's still remaining pretty stable. Actually, it will be a little lower in 2010 than in 2009.

The other – probably the most significant issue is that our tax rates are going to be going up. Our effective rate is still quite low, but it will be higher than what it was last year and the reason it was so low last year, lots of factors. We didn’t make – with the LXE problems, we didn’t make that much money in the U.S., which has our highest tax rate and we made a lot of money outside the U.S., which has a much more favorable tax rate. And in the next year, it starts to even up a little bit as we get back into saddle in terms of earning in the U.S. So that 15% rate makes a big difference.

If you go all the way backwards and back into EBITDA, I think what you are going to find is some modest EBITDA growth in 2010.

Michael Ciarmoli – Boenning & Scattergood

Okay, that's helpful. And just on the LXE business, you've said you've seen some big orders come in, some big bookings. Can you quantify and thinking about how you switched to an indirect model, have some of those orders occurred due to getting your kind of supply chain, your VARs up and running with some inventory? Can you help us there in terms of what those – how that switched to this indirect model and how that correlates with the orders you are seeing?

Gary Shell

I think I will start – Neil has got a couple of comments. I think the fourth quarter, one of the significant things there is up to this point, we've seen probably a little bit of a shift from – as the indirect came up, we've seen somewhat of a shift from direct to indirect. So we weren’t necessarily doing a net gain.

In Q4 though, we are seeing enough of a build in the indirect that we are seeing now the benefit of this and we are seeing net build and what's going on in the pipeline. So that's one of the things that's really contributing as we are starting to see that exposure in more VARs or more players in channel contributing to the better stream of orders coming in.

Neil Mackay

Yes. Gary has pretty well said it the way it is, Michael. What's happened is that as we got into the indirect model, we got more and more VARs signing up and it took them some time, they went through the gestation period, but what's now starting to happen is not just the ScanSources of the world, but the VARs behind them are starting to buy more equipment as well.

Gary Shell

We have been – specifically to your question, Michael, we have done some stocking up, some initial stocking with the new guys, but that hadn't been very much of a factor. That's not like we are drive – the revenues are being driven by some channel stuffing. We are seeing real orders coming out of the channel, which is what got us encouraged.

Michael Ciarmoli – Boenning & Scattergood

Okay, that's helpful. And then two more and I'll get out of the way here. Can you talk about – you mentioned in the Communication and Tracking, you've got – I guess for the aviation side, air-to-ground, Ku, Inmarsat, Iridium, can you talk maybe about the operating margins between those different communication protocols? Are there big discrepancies in what you are seeing, where you recognize profits, do you have some higher margin that you really like to steer customers toward or is it all pretty much balanced?

Neil Mackay

Well, the margins are pretty high on all the various subsystems. What you find though is the content is different on – for each one. The Inmarsat products, you – when you – the ship sets are close to $100,000 or in that kind of area, while if you are setting – while if you are shipping an Iridium product, it could be in the $10,000 range. The percentage margins are pretty good, but there is a difference in the size of a ship set. Does that help you – helpful, Michael?

Michael Ciarmoli – Boenning & Scattergood

That's helpful. So where would you like to see all your ship sets? If you guys had the option, I mean, it sounds like you'd rather see Inmarsat over Iridium. Can you maybe help me with the other two, Aircell and Ku?

Neil Mackay

Well, no. I'm actually – we wanted to be everywhere. What – there will be some price sensitivity. Inmarsat works well for folks who are doing global travelling. In the U.S. though, where 70% of all planes fly, you really want to help Aircell to do better. So we are quite happy to be working with the Aircell for the U.S. We get good margins and also the volumes are pretty high there too.

Michael Ciarmoli – Boenning & Scattergood

Okay. That is helpful. And then last, sticking with the aviation market, looking out to the second half, obviously a lot of guys in that space are talking about an uptick. I mean, are you looking to see it more on – can you help me with – after – is this going to be aftermarket, is it OEM? I mean, I know in-flight connectivity is more of a discretionary offering. So are we getting to the point now where you are seeing orders for that or is this going to come from more of the newbuilds from – I know we are still 787s away from volumes, but can you give us a sense as to what you are seeing kind of aftermarket retrofit versus OEM?

Neil Mackay

Well, it's quite a complex market. There is forward-fit on commercial, there is forward-fit on business, and then there is aftermarket as well and there is kind of a mix that goes on there. The forward-fit on commercial is – will take longer to roll out because the airlines take longer to do these deployments. Business jet folks are much more into instant gratification. So you often see the aftermarket sales coming from the business jet side.

But it's a mix of everything, Michael and it’s hard to separate them because our partners deal with all aspects of that. Honeywell sells to Boeing and to Airbus, so they sell into the commercial area, but they also sell to their specific customers who are airlines and then also there is a – they also sell to the gulf streams of the world. So it's a mix and I would say that the aviation – the commercial aviation side is going to continue to grow slowly. The business jet will be a bit volatile this year.

Michael Ciarmoli – Boenning & Scattergood

Okay. And then last one as I'm thinking here. Who should I watch then, I mean, do we watch guys like Honeywell as a lead indicator of your business, do we watch Rockwell Collins, is it someone like a Thales we should keep an eye on to kind of get a gauge as to how this market is going?

Neil Mackay

Well, yes, you could – all of the above. Honeywell has a really good research group and they keep tabs of what their market is doing. So if you get into their website you will see that they have good projections. Rockwell Collins is a pure-play in connectivity, so you will find that they have much more focus on connectivity as opposed to Honeywell which sells engines and other stuff.

Michael Ciarmoli – Boenning & Scattergood

Sure.

Neil Mackay

Thales, you should look at them because they are in the IFE market, in-flight entertainment, and they just made some announcements of what they are doing. So Thales largely is the air transport side, Honeywell is aviation in general, Collins is connectivity.

The other good thing to keep watching for is flying hours. There are some good research reports on flying hours, which we are now seeing that the business jet market is starting to come back. That's a good leading indicator of what you might see in about six to eight months time.

Michael Ciarmoli – Boenning & Scattergood

Okay and I'm sorry, just as I am thinking here. You mentioned Thales and IFE. A while ago last year, maybe even longer, Panasonic was supposed to be a pretty big opportunity for you guys. Any update there?

Neil Mackay

Yes, we actually are providing the antennas for their Ku-band service and Lufthansa has announced that they will be launching it sometime later on this year. Panasonic has a very vibrant IFE, as well as IFC, the C meaning connectivity. Panasonic is the largest – supplies the largest share of the IFE market. Thales and Panasonic basically own that space.

Michael Ciarmoli – Boenning & Scattergood

Okay. All right, great. Thanks a lot, guys.

Operator

And our next question comes from Ryan Rackley of Raymond James. Please state your question.

Ryan Rackley – Raymond James

Good morning, guys.

Neil Mackay

Hi, Ryan.

Ryan Rackley – Raymond James

Hi. Looking at the DS margins for 2010, are you still expecting those to get back to historical norms and should we expect that to happen in the back-end of the year as well, if you will?

Neil Mackay

Yes.

Gary Shell

Yes, they should. Yes, that's right, Ryan. They should go back to historical norms. Now, they were – when the B-2 was in, they were at a historically high level. I'm not sure they are going to get to the early 2009 percentage level, but one of the differences that we've been really working on is trying to make – particularly with the new initiatives that we are working on over there with products is to – a product focus is to make sure that we can deliver a better profit number at D&S.

So the target is to improve that number as we go forward. Whether they will quite get back to the high point of 2009, I don't think that's going to be the case, but they are going to improve.

Ryan Rackley – Raymond James

Okay, great.

Neil Mackay

To look at it the other way, Ryan, is that we are filling in the B-2 whole and so we are not seeing a real disaster or anything like that that might happen in D&S.

Ryan Rackley – Raymond James

And so looking at this past quarter, would you say you are filling in that hole in line with expectations, better than expected or how is that effort coming?

Neil Mackay

It's coming along pretty well. It was a hole of, what, $17 million to $20 million to fill. We've filled a good bit of it, but as – what happens in D&S of course is that you get the order now and it takes a – six months to actually see the revenues starting to perk up. So again, we are expecting good orders, but it will be towards the end of the year before we see the revenues.

Gary Shell

It will take a full year's worth of work to eventually try to come close to filling that in.

Ryan Rackley – Raymond James

Right, okay. And also looking at your revenue guidance, is – can you provide a breakdown of what you expect organically within the three segments for 2010?

Gary Shell

We are not giving segment guidance too much, Ryan. I think the – what we expect for the year – I have to be a bit broad here. What we expect for the year is that Aviation is certainly going to be the largest group; Aviation and LXE are going to be about the same. The new Global Tracking group will probably be the smallest and D&S will be sort of somewhere in the middle there. I'm sorry, I wish I could give you more guidance on segments, but we just – that's just too difficult to do.

Ryan Rackley – Raymond James

Okay, fair enough. And then – so I guess, well, just looking at free cash flow and CapEx, can you provide an outlook for those for 2010?

Gary Shell

Not specific yet. We are going to give that as we go along in the quarter, although we can give some general discussion about where we are expecting to be in terms of – we expect the 2010 plan to generate another significant chunk of cash this year. You are going to be able to do the math and find that it's a decent EBITDA number and you would expect some pretty good cash to flow through that again.

We – it's possible that CapEx will be going up a bit. It was pretty modest in 2009, it was in the low-double digits, sort of $12 million or $13 million-ish kind of number. That will probably go up a little bit, but certainly not enough to put a big dent in and of itself into cash flow. So we are expecting another good cash year in '10.

Ryan Rackley – Raymond James

Okay, great. Thanks, guys.

Neil Mackay

Thank you.

Operator

Our next question comes from Rich Valera of Needham & Company. Please state your question.

Rich Valera – Needham & Company

Thanks. Gary, just wanted to understand what was going on with the corporate & other category that was actually a positive contribution during the quarter.

Gary Shell

What we normally do, Rich, is in an ideal world corporate – the only thing that shows up much at corporate is basically the 123(R). That's the – that's on a sort of an idealized circumstance and to the extent that expenses run a bit higher than that rate, because we are allocating it out to the operating divisions. If expenses run a bit higher, you will see some expense at corporate. If they run a bit lower, you will see some benefits at corporate.

What you are seeing in corporate there is really the result of some across-the-board cuts, not just at corporate, but that's where if some of it happens to accumulate in terms of like benefits. And we have made some reductions, some delays and things there to sort of hold cost down. So that – what that negative number really represents is lower cost than we had planned for and expected this year. So that's a good thing.

Rich Valera – Needham & Company

And how should we think of it going forward though? You are saying you typically expect that to be the 123(R) expense and how should we think of it, what level should we think of that at?

Gary Shell

Yes, 123(R) should be running typically what – the amortization on that is going to run very similar to what it has run in previous years and you can tell – I'm looking for my notes right now to get that number. You are going to have to give me a second to go through and find that, Rich, but that's what should be there. Otherwise, you can assume that by and large, corporate expenses are going to be allocated to the divisions and so all of that should show up in whatever your projections are there.

Rich Valera – Needham & Company

No, that makes sense. Thank you. And just one clarification on the B-2. I think in around March of last year you got a $36 million, if I recall, B-2 order, which was to be delivered all within the year. So I was just trying to reconcile that with – I think you said – you have indicated there is about a sub-$20 million hole to fill. I'm just trying to understand exactly how much B-2 revenues there actually was in 2009.

Neil Mackay

It was about $27 million in 2009, Rich. Some of that got sawed-off and with the way things got wrapped up and the timing, so it was sub-$30 million number.

Rich Valera – Needham & Company

Okay. So because the way it ended, you never fulfilled the full amount of that order? Okay. That makes sense. And I thought there was a point when you guys might be sort of pursuing some revenues on the way that ended. Is there anything you can say on that?

Neil Mackay

Not much we can say on that at this time, I would say.

Gary Shell

I think we are a lot more focused on things like Hawklink, like what you saw. That's where we see the real future, the real payoff would be in – the best place to spend efforts. We may –

Rich Valera – Needham & Company

Sure. Understood. Thank you.

Operator

(Operator Instructions). Thank you. There appear to be no further questions at this time.

Neil Mackay

Well, thank you very much for coming onto this call and I will turn this over to Perry Tanner.

Perry Tanner

Thanks, everyone for joining the call today and we look forward to seeing you out in the marketplace. Have a good day.

Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.

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